September 24, 2014 / 7:04 PM / 3 years ago

Bank of Canada says its policy can diverge from Fed's

3 Min Read

OTTAWA (Reuters) - Canadian monetary policy can diverge from that of its neighbor to the south, even as the U.S. Federal Reserve's exit from its extraordinary stimulus measures will likely raise market interest rates in Canada and weigh on the loonie, a Bank of Canada official said on Wednesday.

Deputy Governor Timothy Lane also warned that the unwinding of the Fed's policy could pose risks to the financial system globally as asset prices and volatility now reflect liquidity spawned by the accommodative actions of central banks in the United States and other countries.

While Lane said the U.S. Federal Reserve's exit from extraordinary monetary policies is "good news" for Canada as it is a sign a sustained U.S. economic expansion is underway, he added that the normalization of U.S. policy will act to tighten Canadian monetary and financial conditions.

At the end of the day, the Bank of Canada, when deciding policy, will assess the various effects of the Fed's moves in the context of the Canadian economy, Lane said.

"I want to stress that Canadian monetary policy is independent and can diverge from the Fed's policies," he said in a speech. "Looking forward, as always, our rate decisions will depend on the state of the Canadian economy."

The Bank of Canada's main policy rate sits at 1 percent, where it has been for the last four years, while rates in the United States have been at near zero since late 2008.

Many economists expect the Bank of Canada to stay on the sidelines on interest rates until well into next year. In contrast, the Fed is expected to end its bond purchase program in October and a recent poll forecast it will likely start to raise rates in the second quarter of 2015. [ECILT/US]

Answering questions following his speech, Lane said he expects the Fed to start raising rates sometime next year.

"The Bank of Canada appears to be suggesting again to markets it is comfortable in lagging behind (a) policy shift coming from the Fed," Nick Exarhos, economist at CIBC World Markets, wrote in a note.

Lane said the Fed's exit from its bond purchase program, known as quantitative easing, will tend to push up market interest rates in Canada and dampen the U.S. expansion. The effect in Canada would be offset partly by the resulting downward pressure on the Canadian dollar, he added.

He said there is a risk of "some bumps along the way".

"In the event that the Fed's renormalization does not play out smoothly in financial markets, the impact on Canada could be significant."

Asked about Canada's robust housing market, Lane said the country's finance system is more resilient than the U.S. system was during the housing crisis of the past decade there.

"There were a number of flaws in the U.S. system running up to the crisis, which are decidedly not a feature of our system," he said.

Editing by Peter Galloway

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